Airthread Case Solution

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Overview of the case:

The cable Industry had been rapidly transforming over the last decade as a result of advances in technology, changes in regulation and shifts in competitive dynamics.

American Cable Corporation (ACC) was one of the largest cable operators in the United States, believe that only a handful of very large network providers would survive into the future.  The smaller companies would eventually be weeded out through industry consolidation.  As a result, American Cable became an aggressive acquirer.  

This case is about valuation of acquiring a large regional cellular provider company “AirThread” by American Cable Corporation.

The basic premise of the AirThread acquisition was threefold:

1. Better product offerings: The two business combined would complement each other and help them in providing bundled services
2. Entering new markets: Could help the companies expand into the business market thereby reducing their reliance on the retail/residential customers ensuring smoother and more stable cash flows. Increased cost and operating efficiency.
3. Value addition: ACC’s fiber lines could save ATC more than 20% in backhaul costs.

Overview of American Cable Corporation (ACC)

In December of 2007, American Cable Communications (ACC) was one of the largest cable operators in the United States.  

The company’s cable systems passed roughly        : 48.5 million homes

Video subscriber        : 42.1 million

High-speed internet subscriber        : 13.2 million

Landline Telephony subscriber        : 4.6 million

Consolidated revenue 2007        : 30.9 billion

Net income         : 2.6 billion

Currently offers video, internet and landline telephony but no wireless offerings.

Overview of AirThread Connections (AT)

• Provided service in more than 200 markets in 5 geographic regions
• 2007 revenues were expected to be $3.9 billion
• The network covered more than 80 million people

Challenges

• Wireless communications market was intensely competitive
• The competitors had big pockets when compared with ATC
• ATC’s operating costs were approximately 20% higher than its main rivals
• It could not bundle its wireless services with land line, internet or video services
• Avg. revenue per min. decreased from 6.71 to 5.95 cents over the last year
• Cost of acquiring a new customer increased from $372 in 2005 to $487 in 2007
• ATC had lower operating and EBITDA margins compared with its primary rivals
• The above challenges made ATC’s long-term survival doubtful

Valuation Approach:

Though WACC or APV both produce the same result, But in this scenario APV suitable most because:

• Using WACC, one key assumption that firm’s debt –equity ratio is same, but in this case D/E ratio changing year to year.
• Ms. Jennifer Zhang wants to focus on the on-going operations and value the non- operating assets and liabilities separately. Therefore, the APV method is more suitable to meet this unbundling incentive.

APV method:[pic 3]

• VU Could be obtained through discounting the free cash flow in each year:

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• The calculations of the free cash flow (FCFs) can be done by the following calculations:

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• Given the project debt capacity Dt at the end of year t, the tax shield at t+1 is:
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• Then discount the tax shield with the appropriate discount rate the PV of Interest Tax Shield could be obtained. In the end, adding the PV of tax shield and PV of intermediate unlevered cash flow together, the total PV of unlevered firm could be obtained.

Steps:

1. AirThread's Weighted Average Cost Of Capital (WACC)
2. Present value of tax shields
3. Present value Of unlevered Free Cash Flows (FCFs)
4. Terminal value
5. PV of AirThread's Non-operating assets
6. illiquidity discounting

Step1. AirThread WACC

We have used below mentioned figures while calculating unlevered cost of equity